Micro Economy Today 14th Edition Schiller Solutions Manual

Micro Economy Today 14th Edition
Schiller Solutions Manual

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
Chapter 8
THE COMPETITIVE FIRM
WHAT IS THIS CHAPTER ALL ABOUT?

This chapter sets about to relay the basic elements of competition and the competitive firm. The
chapter examines how businesses make price and production decisions. The role of profits is
critical in the production and investment decisions and is examined in detail. The following
questions act as a guide:
1. What are profits?
2. What are the unique characteristics of competitive firms?
3. How much output will a competitive firm produce?
LEARNING OBJECTIVES: After reading this chapter, the students should know:
1. How profits are computed.

2. The characteristics of perfectively competitive firms.
3 How a competitive firm maximizes profit.
4. When a firm will shut down.
5. The difference between production and investment decisions.
6. What shapes or shifts a firm’s supply curve.
NEW TO THIS EDITION

The changes to this chapter include:
 New In the News on Strawberry farm
 New In the News on T-shirt shops
 New World View on GM and Ford plant closures
 Removed In the News on catfish farms
 New Figure 8.12 on Rising MC
 3 revised Questions
 8 revised Problems
 1 new Problem
LECTURE LAUNCHERS
How long will this chapter take? Three 75-minute class periods.
Where should you start?
Chapter 8 – The Competitive Firm

© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner.
This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
The discussion of competitive markets is separated into two chapters in this text: The
Competitive Firm (Chapter 8) and Competitive Markets (Chapter 9). This chapter focuses on
the competitive firm.
1. Ask students what motivates a person to own and operate a business.
Most students will immediately say that profits are the primary motivator.
Remember, there are other motivations to own and operate a business.
2. Pick a local supermarket and ask students to address the following:

a. How do its prices differ from those of its competitors?
b. Are the products it sells different from its competition?
c. What do they perceive to be its profitability?
d. What manifestations do they see of the competitiveness of the market? (For
instance, do they match the prices in advertisements of their competitors, do they
allow double couponing, etc.)
3. Ask students what determines how much output a firm will sell?
Usually, the students will answer the question by saying, “Demand determines
how much they will produce”. This, of course, is only part of the answer.
During this chapter, you will discuss the production decision, profit-maximizing
rule, and the shut down rule. If you get the students to begin thinking about the
production decisions early in the chapter, they will be more receptive to the
discussion later in the chapter.
4. Illustrate that it is important to consider opportunity costs when making business

decisions. A great example is the In the News “The Value of Hiro’s Strawberry Farm”.
During the discussion of economic vs. accounting profits, students often find it
hard to understand why opportunity costs need to be considered when making
a business decision. This article illustrates the concept dramatically.
5. Define the term market power and then ask students to provide examples of firms that
have zero market power.
Most students will have difficulty in providing this example. A litmus test for
such a firm is one who, when raising its price by even a small amount, loses all
of its sales.
COMMON STUDENT ERRORS

Students often believe the following statements are true. The correct answer is explained after
the incorrect statement is presented in italics.
1. Zero economic profits mean that a firm should go out of business. Zero economic profits
means that a firm is still making accounting profits. Because economic profits take into
account economic costs, economic profits will be less than accounting profits. If a firm is
covering its opportunity cost, it can still stay in business even if its economic profits are
zero.
2. If a firm can’t cover its costs, it should shut down. If a firm can’t cover its variable costs,
it should shut down. The shut down decision depends only on variable costs. Even if the
firm can’t cover its economic costs, the firm may have more profits in the short run if it
continues to produce. If the firm shuts down, it loses all the fixed costs; if the firm
continues to produce, the loss will be less than the shutdown loss if revenues are greater
than variable costs.
3. If a firm is taking a loss, it is not maximizing profits. Minimizing losses is essentially

the same as maximizing profits. A firm is maximizing profits as long as there is nothing
it can do to make larger profits. Remember that even if the firm is taking a loss, it will
not shut down if it can cover variable costs.
4. A price taker chooses the price that maximizes profits. A price taker chooses output to
maximize profits at the market price. In a perfectly competitive market, firms must sell
at the market price—or sell no output at all. Perfectly competitive firms adjust output so
that marginal cost equals price. At this level of output, profit is maximized.
4. A firm should always increase the rate of production as long as it is making a profit. If
the increase in production rates generates more costs than revenue, the firm will be less
profitable. In this case, continued expansion will ultimately result in zero profits.
ANNOTATED OUTLINE
I. Introduction
A. The key questions this chapter addresses are:
1. What are profits?
2. What are the unique characteristics of competitive firms?
3. How much output will a competitive firm produce?
II. The Profit Motive

A. The basic incentive for producing goods and services is the expectation of profit.
1. Definition: Profit - The difference between total revenue and total cost.
B. Other Motivations - Personal reasons, such as the need for control or identity, also
motivate producers.
C. Is the profit motive bad?
1. In the News: “Are Profits Bad?”
This In the News provides responses to a Roper survey revealing the public’s
opinion about profits. Forty-two percent of respondents believe that the profit
motive is good causing people to invest and provide money to build plants and
industry. In addition, thirty-nine percent believe the profit system results in
better products at lower prices.
2. The general public is suspicious of the profit motive.
One in four believes the profit motive results in inferior products at inflated
prices.
3. A 2010 poll conducted by Gallup revealed that people are particularly wary of
profits received by “big businesses.”
4. The profit motive can induce business firms to pollute the environment, restrict
competition, or maintain unsafe working conditions.
5. The profit motive also encourages businesses to produce the goods and services
consumers’ desire at prices they’re willing to pay.
6. The profit motive moves the “invisible hand of the market”.
7. The challenge is to direct market outcomes in the directions we wish.
III. Economic vs. Accounting Profits

A. Economic profits (Table 8.1)
1. Definitions:
 Economic cost - The value of all resources used to produce a good or
service; opportunity cost.
 Explicit cost – A payment made for the use of a resource.
 Implicit cost – The value of resources used, for which no direct payment
is made.
2. Whenever economic costs exceed explicit costs, observed (accounting) profits will
exceed true (economic) profits.
3. Definition: Economic profit – The difference between total revenues and
total economic costs.
4. Formula
Economic total total economic

profit = revenue - cost
accounting implicit
profit - costs
5. Economic profit accounts for all resources

 Economic profits represent something over and above "normal profits”.
 A productive activity reaps an economic profit only if it earns more than
its opportunity cost.
6. Definition: Normal Profit – The opportunity cost of capital; zero economic
profit.
8. In the News: “The Value of Hiro’s Strawberry Farm”
A strawberry farmer continues to make accounting profits and stay in business.
Accounting profits, however, may overstate the profitability of an enterprise by
failing to consider the opportunity cost of all resources used in production. If the
opportunity cost of the land were deducted, this farm would show an economic
loss. It is located across from Disneyland; the owner has been offered purchase
or lease prices —much more than he earns from farming.
B. Entrepreneurship - The inducement to take on the added responsibilities of owning
and operating a business is the potential for economic profit.
C. Risk - The potential for profit is not a guarantee of profit.
IV. Market Structure (Figure 8.1)

A. The opportunity for profit may be limited by the structure of the industry.
1. Definition: Monopoly - A firm that produces the entire market supply of a
particular good or service.
2. Definition: Market Structure - The number and relative size of firms in an
industry.
3. Definition: Perfect Competition - A market in which no buyer or seller has
market power.
4. In the News: “Too Many Sellers: The Woes of T-Shirt Shops”
Too many T-shirt shops limit the market power of existing shops. The ability of a
single firm to change the price of its product depends on how many competitors
offer identical products.
V. The Nature of Perfect Competition

A. Structure – Perfectly competitive markets are characterized by:
1. Many firms—Lots of firms are competing for consumer purchases.
2. Identical products—The products of the different firms are identical, or nearly so.
3. Low entry barriers—It’s relatively easy to get into the business.
B. Price Takers
1. Definition: Market Power - The ability to alter the market price of a good or
service.
2. A perfectly competitive firm is one whose output is so small in relation to market
volume that its output decisions have no perceptible impact on price.
C. Market demand curves vs. firm demand curves. (Figure 8.2)
1. The market demand curve for a product is always downward-sloping (law of
demand).
 Collectively unified producers may impact (move) the market supply
curve.
 The intersection of the market demand and market supply curves set the
market price.
2. The individual firm’s demand curve
 Is horizontal based on the established market price.
 Indicates the firm cannot affect the price.
VI. The Production Decision

A. Definition: Production Decision – The selection of the short-run rate of output
(with existing plant and equipment).
B. Output and revenues
1. In searching for the most desirable rate of output, the distinction between total
revenue and total profit must be kept in mind.
2. Definition: Total Revenue - The price of the good multiplied by the quantity
sold in a given time period: p  q. (See Figure 8.3.)
3. Formula
Total revenue  price  quantity
4. The objective is to maximize profits, which does not necessarily mean

maximizing revenues.
5. The total revenue curve of a perfectly competitive firm is an upward-sloping
straight line, with a slope equal to pe.
C. Output and costs
1. To maximize profits a firm must consider how increased production will affect
costs as well as revenues.
2. Producers are saddled with certain costs in the short run.
 Definition: Short-run - The period in which the quantity (and quality
of some inputs can’t be changed.

3. Definition: Fixed Costs - Costs of production that don’t change when the
rate of output is altered, e.g., the cost of basic plant and equipment.
 Fixed costs are incurred even if no output is produced
4. Once a firm starts producing output, it incurs variable costs as well.
 Definition: Variable Costs - Costs of production that change when
the rate of output is altered, e.g., labor and material costs.
5. Total costs increase as output expands. But the rate of cost increase varies. This
reflects the law of diminishing returns. (See Figure 8.4.)
6. As we first observed last chapter, marginal costs often decline in the early stages
of production and then increase as available plant and equipment are used more
intensively.
7. Definition: Marginal Cost (MC) – The increase in total costs associated with
a one-unit increase in production.
8. Total profit is the difference between total revenue and total cost. (See Figure
8.5.)
VII. Profit-Maximizing Rule

A. Marginal revenue = price
1. Definition: Marginal Revenue (MR) - The change in total revenue that
results from a one-unit increase in the quantity sold.
2. Formula
change in total revenue
Marginal revenue 
change in output
3. For perfectly competitive firms, price equals marginal revenue. (Table 8.2.)
B. Marginal cost (Figure 8.6)
1. The added cost of producing one more unit of a good is its marginal cost.
2. The primary objective of the producer is to find that one particular rate of output
that maximizes profits.
C. Profit-maximizing rate of output (Figure 8.7)
1. What an additional unit of output brings in is its marginal revenue (MR); what it
costs to produce is its marginal cost (MC).
2. Profits are maximized at the rate of output where price equals marginal cost.
3. Definition: Profit-Maximization Rule –Produce at that rate of output
where marginal revenue equals marginal cost.
4. Short-run Profit-maximization rules for competitive firm. (Table 8.3)
Price Level Production Decision

price > MC increase output
price = MC maintain output (profits maximized)
price < MC decrease output
5. In the News: “Southern Farmers Hooked on New Cash Crop”

Catfish are replacing crops and dairy farming as a cash industry in much of the
South, particularly in Mississippi’s Delta region, where 80 percent of farm-bred
catfish are grown. People go into a business like catfish farming to earn a profit.
Once in business they try to maximize total profits by equating price and
marginal cost.

D. Adding up profits (Figure 8.8. and 8.9)
1. Formula
Total profits = TR – TC
also
Total profits = profit per unit x quantity

= (p – ATC) x q
2. The profit-maximizing producer never seeks to maximize per-unit profits. What

counts is total profits, not the amount of profit per unit.
3. The profit-maximizing producer has no desire to produce at that rate of output
where ATC is at a minimum. That is not necessarily the profit maximizing point.
VIII. The Shutdown Decision

A. Fixed costs must be paid even if all output ceases.
1. A firm should shut down only if the losses from continuing production exceed
fixed costs.
B. Price vs. AVC
1. Where price exceeds average variable cost but not average total cost, the profit
maximization rule minimizes losses.
C. The Firm’s Shutdown Point
1. Definition: Shutdown Point – That rate of output where price equals
minimum AVC.
2. Where price doesn’t cover average variable costs at any rate of output, production
should cease.
D. Summary (See Figure 8.10.) – This summarizes the three possible production decisions
for a firm.
1. Profit: P > ATC
2. Loss: ATC > P > AVC
3. Shutdown: AVC > P
IX. The Investment Decision

A. Definition: Investment Decision – The decision to build, buy, or lease plant and
equipment; to enter or exit an industry.
1. Investment decisions are long-run decisions.
2. Definition: Long-run – A period of time long enough for all inputs to be
varied (no fixed costs).
B. Long-Run Costs
1. A producer will want to build, buy or lease a plant that’s the most efficient for the
anticipated rate of output.
C. World View: “GM Closing 15 Plants for 9 Weeks” and “Ford to Shutter
Australian Plants”
The first article describes GM’s plans to shut down—in the short run—several automobile
assembly plants. The second article describes the elimination of jobs at Ford due to the
permanent closure of one of its plants—a long-run decision.

X. Determinants of Supply
A. Short-run determinants
1. The price of factor inputs.
2. Technology (the available production function).
3. Expectations (for costs, sales, technology).
4. Taxes and subsidies.
B. The marginal cost curve is the short-run supply curve for a competitive firm (after it
intersects the AVC curve).
C. Definition: Supply Curve – A curve describing the quantities of a good a producer is
willing and able to sell (produce) at alternative prices in a given time period, ceteris
paribus.
D. Supply shifts - If any determinant of supply changes, the supply curve shifts.
A. As production costs increase supply decreases and the curve shifts upward.
B. As production costs decrease supply increases and the curve shifts downward.
XI. Tax Effects (Figure 8.13)

A. Property taxes
1. Property taxes are a fixed cost.
2. The production decision isn’t affected by property taxes but investment decisions
can be.
B. Payroll taxes
1. Payroll taxes increase marginal costs.
2. Any time the MC curve shifts, ATC must shift as well, this affects production
decisions.
C. Profit taxes
1. Do not affect production level decisions but because they reduce after-tax profits,
which lessen the incentive to invest, they can affect investment decisions.
D. Tax Policy
1. Tax policy affects production and investment decisions.
XII. The Economy Tomorrow: Internet-based Price Competition

E-commerce has increased competition and decreased transaction costs. It also gives
retailers a tax break. In 2010, consumers spent over $200 billion on electronic
purchases. Net sales are accelerating each year.

IN-CLASS DEBATE, EXTENDING THE DEBATE, AND
DEBATE PROJECT
In-class Debate
What are the club’s fixed and variable costs?
Imagine that you are asked to consult with a drama club that puts on a play every year. The club
asks you: How much should we charge for tickets if we want to cover our costs? You begin by
listing the club’s fixed and variable costs and then make a recommendation for a ticket price.
Give the club three examples of each type of cost.
Fixed costs Variable costs

1. 1.
2. 2.
3. 3.
What is your recommendation for ticket pricing? Do you cover just fixed costs or both costs?
Teaching note
After students have answered the question individually, post three signs on different walls of the
room labeled: Fixed costs only; Variable costs only; both fixed and variable. Ask students to
stand up and move to the part of the room representing their position. Call on individual
students to explain their position. Announce that students may shift position if they change their
minds based on student comments.
Ask students to pair with someone who has the same position. Together they might write a
paragraph explaining their position. Follow with a cooperative controversy. Format: Pairs
combine into groups of four, with one pair on each side of the debate. One pair reads their
reasons while the other side listens. Then they reverse roles, so that the other pair reads. After
that, each group of four selects strongest argument on each side.

Extending the Debate
How does tax policy affect business decisions?
The chapter discusses the effects that tax policy has on business decisions. How do these taxes
affect business decisions regarding investment and/or production decisions?
a) Property taxes
b) Payroll taxes
c) Profit taxes
Teaching note
After students have answered the question individually, post signs on different walls of the room
labeled with the types of taxes. Ask students to stand up and move to the part of the room
representing the tax that affects business the most. Call on individual students to explain their
choice.
Follow with an individual writing assignment on how tax policy affects business decisions.
Debate Project
Wal-Mart: Competitive wonder or community nightmare?

The most successful firm in US retailing during the last few years is Wal-Mart. Has Wal-Mart’s
success fulfilled the virtues of competition? Has there been a cost of Wal-Mart’s success?
Find out what the critics contend at: http://www.walmartwatch.com/ List the problems
allegedly caused by Wal-Mart for its employees, local communities, consumers, and the
environment.
Find out how Wal-Mart responds at:

http://www.walmartstores.com
What is the most serious charge against Wal-Mart?
What is the most significant benefit Wal-Mart offers?
Teaching Notes
Here is a way to lead up to an in-class discussion on Wal-Mart: Use student input to determine
the most serious problem related to Wal-Mart, perhaps by asking students to identify the
category of problem they think most important. Have them do this by moving to a side of the
room labeled: 1) employees; 2) local communities; 3) consumers, and 4) the environment. Call
on students on each side to explain the problems they see. Students may move to another side

as they hear student explanations. You can select the problem of most concern to the students
based on which side of the room has the most students.
Once the critical issue is determined, write a policy statement that might address the student
concern, such as: “Minimum standards should be set for worker benefits at large employers such
as Wal-Mart,” or, “Local votes should be required before stores as large as Wal-Mart are allowed
to enter a community.”
Organize an in-class debate based on the statement using a cooperative controversy format.
Organize students into groups of two. (Use instructor assignment or random assignment so that
friends don’t work together.) One half of the groups takes the pro side; the other half takes the
con side. Each pair lists the strongest three arguments for their position. Then pairs combine
into groups of four with one pair on each side of the debate. One pair reads their reasons while
the other side listens. Then reverse so that the other pair reads their reasons. Group of four
selects strongest argument on each side and, if appropriate, reaches consensus on final position.

PRINT MEDIA EXERCISE
Name:
Chapter 8 Section:
The Competitive Firm Grade:
Find an article that describes either a shift of supply or a movement along a supply curve. Use
the article you have found to fulfill the following instructions and questions:
1. Mount a copy (do not cut up newspapers or magazines) of the article on a letter-sized page.
Make sure there is room at the bottom of the article to write the answers to the questions.
2. Below your article write one of the following four responses that best characterizes the
change that you are representing:
 A leftward (upward) shift of the supply curve.
 A rightward (downward) shift of the supply curve.
 A leftward (downward) shift of the demand curve.
 A rightward (upward) shift of the demand curve.
3. Use an arrow to indicate in the article the product or product market in which the shift or
movement occurs.
4. Underline the single sentence (not more than a sentence) that describes the change in the
determinant of supply or price that has caused the shift you chose in number 2.
5. Draw brackets around the word or phrase (not more than a sentence) that indicates who the
seller is.
6. Circle the single sentence (not more than a sentence) that describes a change in price or
quantity that results from the shift in supply or that causes the movement along the supply
curve. (Hint: Be sure that the changes are consistent with the shift you chose in number 2. If
a demand determinant has changed or the article shows that the seller has changed quantity
or price, then you should indicate a movement along the supply curve, not a shift.)
7. Below the article write one of the following four changes in equilibrium output and price that
should occur as a result of the shift you have chosen in number 2 above:
 Higher price and higher output.
 Higher price and lower output.
 Lower price and higher output.
 Lower price and lower output.
8. In the remaining space below your article, indicate the source (name of newspaper or
magazine), title (newspaper headline or magazine article title), date, and page for the article
you have chosen. Use this format:
Source: __________________________ Date: ______________ Page: ________

Title:___________________________________________________________
If this information also appears in the article itself, circle each item.
9. Neatness counts.
Professor’s Note
Learning Objective for Media Exercise
To have students distinguish between shifts in the supply curve and movements along the
supply curve, to get students to recognize immediately any supply determinants in the news, to
show students how to make predictions about the impact of supply determinants on equilibrium
price and output, and to familiarize students with other sources of information to give clues to
the effects on supply.
Suggestions for Correcting Media Exercise
1. Check for consistency between the underlined event of the article and the movement or shift
chosen to illustrate the event.
2. Check for consistency between the circled part of the article and the prediction about the
effect on equilibrium prices and output in the market (number 7).
3. Check for consistency among the movement or shift (number 2), their prediction about the
effect on equilibrium prices and output (number 7), and the evidence found on the actual
changes in prices and output (number 6). Quite often students will be confused by more
than one shift.
Likely Student Mistakes and Lecture Opportunities
1. Sometimes students may repeat the Chapter 6 assignment by finding demand shifts or
demand determinants. This is a useful opportunity to distinguish between the buyer and the
seller in a transaction and to reiterate the difference between supply and demand.
2. Many difficult markets, particularly the commodities markets, can cause confusion for the
students. (See notes to Chapter 2 assignment.)
3. Students occasionally have problems distinguishing substitute goods which have an
influence on demand, and changes in goods that compete with factors of production (and
alter the opportunity cost of those factors of production). If the students find examples of a
change in substitutes and call it a supply shift, they are unclear about what market they are
working with. Again this is due to a choice of the wrong vertical market.
SUPPLEMENTARY RESOURCES
Garson, Barbara: Money Makes the World Go Around. Viking Press, 2001. Upbeat an offbeat
description of global competition by a journalist who follows her bank deposit around the
world in global commerce.
Womack, James, et al.: The Machine That Changed the World, Rawson Associates, New York,
1990. Details in an easily readable style and with excellent data the competition between the
major auto producers.


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Micro Economy Today 14th Edition

Schiller Solutions Manual

THE COMPETITIVE FIRM

WHAT IS THIS CHAPTER ALL ABOUT?

1. How profits are computed.

NEW TO THIS EDITION

Where should you start?

Chapter 8 – The Competitive Firm

2. Pick a local supermarket and ask students to address the following:

4. Illustrate that it is important to consider opportunity costs when making business

COMMON STUDENT ERRORS

3. If a firm is taking a loss, it is not maximizing profits. Minimizing losses is essentially

II. The Profit Motive

III. Economic vs. Accounting Profits

Economic total total economic

5. Economic profit accounts for all resources

IV. Market Structure (Figure 8.1)

V. The Nature of Perfect Competition

VI. The Production Decision

4. The objective is to maximize profits, which does not necessarily mean

Chapter 8 – The Competitive Firm

VII. Profit-Maximizing Rule

Price Level Production Decision

5. In the News: “Southern Farmers Hooked on New Cash Crop”

Chapter 8 – The Competitive Firm

Total profits = profit per unit x quantity

2. The profit-maximizing producer never seeks to maximize per-unit profits. What

VIII. The Shutdown Decision

IX. The Investment Decision

Chapter 8 – The Competitive Firm

XI. Tax Effects (Figure 8.13)

XII. The Economy Tomorrow: Internet-based Price Competition

Chapter 8 – The Competitive Firm

Give the club three examples of each type of cost.

Fixed costs Variable costs

Chapter 8 – The Competitive Firm

Wal-Mart: Competitive wonder or community nightmare?

Find out how Wal-Mart responds at:

What is the most serious charge against Wal-Mart?

What is the most significant benefit Wal-Mart offers?

Chapter 8 – The Competitive Firm

Chapter 8 – The Competitive Firm

Source: __________________________ Date: ______________ Page: ________

Suggestions for Correcting Media Exercise

Likely Student Mistakes and Lecture Opportunities

Chapter 8 – The Competitive Firm

You might also like

Source: ________________ Date: Page: